Should ethical investors dip into water stocks?

July 14, 2008

Just as the world may be peaking in oil production, experts are warning of "peak water" – looming water shortages that many see as an investment opportunity. But profiting from water can be ethically tricky. The Monitor's Laurent Belsie sat down to discuss the issues with Chris Brown, chief investment strategist and portfolio manager for Pax World Balanced Fund, and Eric Fernald of KLD Research & Analytics. Here are edited excerpts of their conversation:

Is there such a thing as "peak water"?

Eric Fernald: I'd say yes and no. No, it's not exactly a correlate to oil being a finite resource. It's a renewable source. By most estimates, globally, we've only reached a third of our usage of fresh-water capacity. That being said, yes, there is a crisis.... When you have a billion people who don't have access to fresh water, when you have by some estimates 6,000 children dying a day because of lack of access to clean water, these are crisis numbers.

Chris Brown: It's a very exciting theme right now from an investment perspective.... China is probably going to spend about $120 billion on water infrastructure over the next few years. The United States actually has a lot of crumbling infrastructure here with pipes that were put in the ground back in the '50s and now they all need to be replaced. So it's everywhere. And we've focused on water-infrastructure companies.

Water seeps into all kinds of industries. Are some more ethical than others?

Fernald: The low-hanging fruit is the water-efficiency side, where companies are focusing on technological developments to make improvements.

Brown: For example, Emerson Electric is a holding in the [Pax World Balanced] fund, and they provide uninterruptible power sources, surge protectors, which help the efficiency of wastewater-­treatment plants. So it keeps these plants running at a very efficient pace. Also companies that make valves and pumps, I think those are pretty exciting [and] probably the least of the controversial companies out there.

And water privatization?

Fernald: You have to tread very carefully and you have to keep close tabs on your investments. There are some high-profile NGO [nongovernmental organization] campaigns now on this very issue. And there have been some very-high-profile cases where companies have had to pull out or lost their contracts – the most famous one being Suez in Bolivia, after mass protests [about] raising the cost of water. South Africa is also going through a very similar conflict.

The issue is: Should private firms own people's water?

Brown: We really have to look at these companies: Are they more focused on profits rather than quality or service? We look at [environmental] violations. Mismanagement of that is an issue and that's something as an investor we have to focus on and make sure they're managing responsibly.

Any company that stands out?

Brown: Two companies that have met our environmental, social, and governance criteria have been American Water Works [and] Aqua America.... There's always room for dialogue with these companies. Issues do come up and we do have to speak with the company. But as a shareholder, that's a pretty powerful voice to talk ... about issues.

Why is bottled water a target now?

Fernald: That's probably the hottest topic in water right now, certainly in the US and I think now globally. Nestlé, Pepsi, Coca-Cola – all major players in this market. Ironically, right here in Massachusetts there's a big debate about water supplies and the issue of privatization of water, communities getting the right price for their water. And obviously on the waste side, the use of plastics and the plastic bottle and the cost of disposing of them.

Have you sorted that out at Pax?

Brown: We do own PepsiCo, which obviously does have its exposure. Again, this is part of where dialogue comes up on being an ethical investor. We open a dialogue with companies like that to see what they're doing to minimize this type of activity or impact on the environment.

Fernald: I think Pepsi is a good example, actually, where they've had a number of initiatives at the corporate level and – only as a large company like Pepsi can – a global initiative. They partnered recently with the Earth Institute at Columbia University – that's [directed by] Jeffrey Sachs. And they've also partnered with H2O Africa, which focuses on sustainable water in Africa.... I also notice that on their industrial food-processing side, they won some recent [Environmental Protection Agency] awards on improving the use of water within their industrial processes. That's the whole picture you've got to really look at. You've got to balance. They're involved in the bottled-water industry, but what else are they doing to mitigate that or to improve the overall picture of water globally? As a large company, they can really have an influence there.

Another issue is desalination.

Brown: Desalination is probably one of the more exciting areas now, especially here in the United States. You have an aging population moving into areas that are very arid, particularly the southwestern part of the United States. And there's just not enough water. So we have focused on companies like Veolia that actually build the plants. But there are issues. There are issues with the waste.... [Also] how much energy does it require to process this water?

Oil investors have seen big profits. Do water firms have the same potential?

Fernald: Four years ago, if you had invested in a lot of the smaller solar companies, it was hard to go wrong. One would assume that water has some of those opportunities as well. I was asking one of our analysts about a smaller company and she pointed to Lindsay Corporation.... This is a company trying to make more efficient use of water through their irrigation systems. Very exciting technology. Companies like that will be very interesting to explore.